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Real Estate Investment Analysis Formulas
Income and Expense Statement


Potential Gross Income (PG1) $__________

Less: Vacancy and Bad Debt Allowance __________

Equals: Effective Gross Income (EGI) $__________

Operating Expenses

Exclude: Depreciation

Mortgage Payments

Non-Operating Expenses. E.G Directors Salaries

Capital Expenditures $__________

Net Operating Income (NO1) __________

Less: Debt Service (P + I) __________

Cash Flow Before Tax (CFBT) __________

Less: Income Taxes __________

Equals Cash Flow After Tax (CFAT) $__________

Financial Measures:

Potential Gross Income Multiplier (PGIM)

Also called Potential Gross Rent Multiplier(PGRM)

PGIM = Market Value or Market Value = Potential Gross Income x PGIM

Potential Gross Income


= MV


Effective gross Income Multiplier (EGIM)

Also called Effective Gross Rent Multiplier(EGRM)

EGIM = Market Value or Market Value = Effective Gross Income x EGIM

Effective Gross Income


= MV


Net Income Multiplier (NIM)

NIM = Market Value or Market Value = Net Operating Income x Net Income Multiplier

Net Operating Income


= MV


Capitalization Rate (Cap Rate)

Also called Broker’s Yield

Cap Rate(%) = Net Operating Income x 100 or Market Value = Operating Income x 100

Market Value Cap Rate(%)

= NOI x 100 MV = NOI x 100

MV Cap Rate(%)

Return on Equit y(ROE)

Also called: Equity Dividend Rate(EDR)

Cash on Cash Return

ROE(%) = (Net Operating Income – Debt Service) x 100


Where: Equity = Market Value – Mortgage

Debt Service = Principal & Interest Payment or MV = (NOI-DS) x 100 + Mortgage


ROE(%) = Cash Flow Before Tax x 100


ROE(%) = (NOI–DS) x 100


Default Ratio (Break-even) (%)

Using Potential Gross Income Using Effective Gross Income

= (Operating Expenses + Debt Service) x 100 = (Operating Expenses + Debt Service) x 100

Potential Gross Income Effective Gross Income

Financing Measures.

Debt Service Ratio (DSR) Loan to Value Ratio (%)

= Net Operating Income = Loan Amount x 100

Debt Service Market Value

Rental Apartment Building Measures.

1. Price Per Suite

2. Price Per Sq. Foot (Using Suite Areas)

3. Rents Per Sq. Foot per month

4. Operating Costs

a. Operating Costs Per Suite Per Year

b. Operating Cost per Sq. Foot per Year

5. Operating Expense Ratio (OER) = Operating Expense x 100

Effective Gross Income

Home Financing:

Gross Debt Service Ratio = (Principal + Interest + Taxes)

Gross Family Income

Lenders often modify the basic Gross Debt Service Ratio Formula.

Modified Gross Debt Service Ratio = (Principal + Interest + Taxes + Heat + % of Maintenance

Gross Family Income

Total Gross Debt Service Ratio = (Principal + Interest + Taxes + Other Debt Payments)

Gross Family Income

Commercial Real Estate Sample Calculations

The following examples illustrate how to use the real estate formulas. In Example No.1 the information is obtained for the property and

the financial measures calculated. In Example No. 2 the financial measures such as the Cap Rate are obtained for comparable sales and

are used to calculate the Market Value for the subject property.

Example No 1.

Sale Price (Market Value) $3,165,000

Potential Gross Income: $306,000

Vacancy & Bad Debt Allowance: 4.5%

Operating Expenses $58,000

Mortgage $2,056,000

Mortgage Payment (P+i) $180,538

Number of Suites 30

Total Rentable Area 24,000 Square feet

Note: All figures are annual

Calculate: Potential Gross Income Mulitplier (PGIM)

Effective Gross Income Multiplier (EGIM)

Net Income Multiplier (NIM)

Capitalization Rate (Cap Rate)

Return on Equity (ROE)

Default Ratio (Break even) based on:

Potential Gross Income

Effective Gross Income

Debt Service Ratio (DSR)

Loan to Value Ratio

Price per Suite

Price per Square Foot

Rent per Square Foot per Month

Operating Cost per Suite per Year

Operating Cost per Square Foot per Year

Operating Expense Ratio (OER) based on:

Potential Gross Income

Effective Gross Income

1. Construct an Annual Income and Expense Statement

Potential Gross Income $306,000

Less Vacancy & Bad Debt Allowance (4.5%) 13,770

Effective Gross Income $292,230

Operating Expenses 58,000

Net Operating Income $234,230

Less; Debt Service (P+i) 180,538

Cash Flow Before Tax $ 53,692

2. Calculate the Financial Measures

Potential Gross Income Multiplier (PGIM):

PGIM = MV = 3,165,000

PGI 306,000

= 10.34

Effective Gross Income Multiplier (EGIM):

EGIM = MV = 3,165,000

EGI 292,230

= 10.83

Net Income Multiplier (NIM):

NIM = MV = 3,165,000

NOI 234,230

= 13.51

Capitalization Rate (Cap Rate):

Cap Rate = NOI = 234,230 x 100

MV 3,165,000

= 7.40%

Return on Equity (ROE):

ROE = (NOI – DS) x100 = Cash Flow Before Tax x 100

EGI Equity

= 53,692 x 100

(3,165,000 - 2,056,000)

= 4.84%

Default Ratio (Breakeven):

Based on Potential Gross Income:

Default Ratio = (Operating Expenses + Debt Service) x 100

Potential Gross Income

= (58,000 + 180,538) x 100


= 77.95%

Default Ratio (Breakeven) cont.

Based on Effective Gross Income:

Default Ratio = (Operating Expenses + Debt Service) x 100

Effective Gross Income

= (58,000 + 180,538) x 100


= 81.63%

Debt Service Ratio (DSR) = Net Operating Income

Debt Service

= 234,230


= 1.30

Loan to Value Ratio % = Loan Amount x 100

Market Value

= 2,056,000 x 100


= 64.96%

Price Per Suite = 3,165,000


= $105,500

Price per Square foot = 3,165,000


= $131.88

Rent Per Sq. Foot per Mo. = 306,000

24,000 x 12

= $1.06

Operating Costs Per Suite Per Year

= 58,000


= $1,933

Operating Cost per Square foot per year

= 58,000


= $2.42

Operating Expense Ratio (OER)

Based on Potential Gross Income:

= Operating Expenses x 100

Potential Gross Income

= 58,000 x 100


= 18.95%

Based on Effective Gross Income:

= Operating Expenses x 100

Effective Gross Income

= 58,000 x 100


= 19.85%


Potential Gross Income Multiplier (EGIM): 10.83

Potential Gross Income Multiplier (EGIM): 10.83

Net Income Multiplier (NIM): 13.51

Capitalization Rate (Cap Rate) 7.40%

Return on Equity (ROE) 4.84%

Default Ratio (Break even) based on:

Potential Gross Income 77.95%

Effective Gross Income 81.63%

Debt Service Ratio (DSR) 1.30

Loan to Value Ratio 64.96%

Price per Suite $105,000

Price per Square Foot $131.88

Rent per Square foot per month $1.06

Operating Cost per Suite per Year $1,933

Operating Cost per Square Foot per Year $2.42

Operating Expense Ratio (OER) based on:

Potential Gross Income 18.96%

Effective Gross Income 19.85%

Example No 2.

Potential Gross Income: $244,800

Vacancy & Bad Debt Allowance: 5.0%

Operating Expenses $49,300

Mortgage $1,685,000

Mortgage Payment (P+i) $147,500

Number of Suites 24

Total Rentable Area 18,720 Square feet

Note: All figures are annual

Calculate the Market Value using the following financial measures

Effective Gross Income Multiplier (EGIM): 9.30

Net Income Multiplier (NIM): 12.50

Capitalization Rate (Cap Rate): 8.00%

Return on Equity (ROE): 5.57%

1. Start by constructing the Annual Income and Expense Statement

Potential Gross Income $244,800

Less Vacancy & Bad Debt Allowance (5.0%) 12,240

Effective Gross Income $232,560

Operating Expenses 49,300

Net Operating Income $183,260

Less; Debt Service (P+i) 147,500

Cash Flow Before Tax $ 35,760

2. Calculate the Market Value based on the:

Effective Gross Income Multiplier (EGIM):

MV = Effective Gross Income x EGIM

= 232,560 x 9.30

= $2,162,808

Net Income Multiplier (NIM):

MV = Net Operating x NIM

= 183,260 x 12.50

= $2,290,750

Capitalization Rate (Cap Rate):

MV = Net Operating Income x 100

Cap Rate

= 183,260 x 100


= $2,290,750

Return on Equity (ROE):

MV = (NOI - DS) x 100 + Mortgage


= (183,260 - 147,500) + 1,685,000


= $2,327,011

Overview on Short Sales and Foreclosures
The Basics of “Short Sales”
by William Bronchick

You will likely come across dozens of properties in foreclosure with little or no equity, that is, the seller owes at close to or more than the property is worth. In these situations, lenders are sometimes willing to accept less than the full amount due, commonly referred to a "short pay" or "short sale."

Negotiating a short sale with the lender is a difficult process, generally because it is a daunting task finding a bank officer who has the authority to accept a discount. You will have to call around to locate the lender’s “Loss Mitigation Department.” More than likely, each lender you deal with will have a separate name for this department, so be patient when calling. Much like getting your phone bill corrected, you can expect the process to involve a lot of waiting on hold and being bounced around an intricate maze of automated voice mail systems. Once you get in touch with the right person, then the negotiating begins.

From the lender’s perspective, a short sale saves many of the costs associated with the foreclosure process - attorney fee's, the eviction process, delays from borrower bankruptcy, damage to the property, costs associated with resale, etc. In a short sale scenario, the lender gets the property back faster, so it is able to cut its losses. Your job as the investor is to convince the lender that it will fare better by accepting less money now.

The lender will want some information about the property, the borrower and the deal he has made with you. Specifically, the lender wants to know what the property is worth. The lender will generally hire a local real estate broker or appraiser to evaluate the property (called a broker’s price opinion or “BPO”). You can also submit your own appraisal or comparable sales information. In addition you will want to offer as much specific negative information about the property as possible. Also, include some relevant information about the neighborhood and the local economy if things are bad (copies of newspaper articles with “bad news” may help). A contract’s bid for repair estimates should also be submitted, which, of course, should be the highest bid you can obtain!

The lender will also ask for financial information about the borrower. Sort of a backwards loan application, the borrower must prove that he is broke and unable to afford the payments. The borrower must show that he has no other source of income or assets to repay the loan. This process may involve as much, if not more paperwork than an original mortgage application! The borrower should submit a “hardship letter”, which is basically a sob story about how much financial trouble the borrower is in. This may require a little literary creativity, and some help on your part. Don’t lie, just paint a picture that doesn’t look good.

Finally, the lender generally wants to see a written contract between you and the seller. The lender wants to make sure the seller isn’t walking away with any cash from the deal. Generally, the contract must be written so that the buyer pays all costs associated with the transaction, so that the “net cash” to the seller is the exact amount of the short pay to the lender. A preliminary HUD-1 settlement statement is often requested, which can be difficult, since many title and escrow companies simple won’t prepare one in advance of closing. You can prepare your own HUD-1, and simply write “preliminary” on the top.

Don’t be surprised if your short sale bid is rejected. Lenders aren’t emotionally attached to their properties, so they aren’t as likely to give you “steal.” Many short sales fall through if the BPO comes in too high, which is often the case. You can’t pull the wool over a lender’s eyes - if the property isn’t is need of serious repair, it is unlikely you can convince the lender the property is worth a whole lot less than the appraised value.

If you are interested in these properties please contact me and I can furnish you a list of properties

Ask many a home buyer about the type of house they are looking for and many will reply "We are looking for something we can fix up and live in (or resell). We like the idea of gaining some quick sweat equity." The classic "fixer-upper" home. Unfortunately, there is a bit of fantasy in the notion, though. First of all, there are many more fixer-upper buyers than there are fixer-upper properties. Second, the current thinking in many minds is that anyone can make a killing in the Real Estate market, which is not always the case. Third,
many buyers totally mis-estimate both the cost and the time involved in fixer-uppers, severely impacting (and in some cases destroying) the profit potential. Unless you are fully prepared to deal with the realities of fixer-uppers rather than the fantasies, it probably is a good idea to look elsewhere for a home.

This does not mean that there isn't equity to be gained (or profit to be made) by purchasing the RIGHT property at the RIGHT price. The important notion is to understand that there are several factors that will make the difference between winning and losing in such a transaction.

The Mindset

The first factor that must be understood is that it isn't going to be easy. The only people who think that finding, buying, fixing and selling a home is an easy task are those who have never done it. Those with any experience (even if only once) will tell you that it rarely is as simple as it appears. In general, it is best to assume that repairs will cost twice what you estimated, take double the amount of time and,when finished, the house will be worth less than expected. If you keep that in the forefront of your thinking, the chances of being burned are much less.

Foreclosure sales are often good sources for fixer-upper properties. A couple of resources that specialize in listings of those types of homes are and . All three of the resources above offer free trial periods to evaluate their services and search for foreclosure listings in the area in which you are interested.

Start Out Small

Some of the worst examples of mistakes made by buyers of fixer-uppers are first-time buyers who bite off way more than they can chew. Examples of this are houses that have structural problems or will take an exceptionally long time to repair, or are located somewhere other than a desirable neighborhood. These can be a horrible drain on finances, time and peace of mind.

A much better strategy for the inexperienced is to purchase a home in a desirable neighborhood that is in need of cosmetic attention--new paint, carpeting, appliances, landscaping and the like. These repairs can either be handled by the homeowner or are easily contracted out, saving time, effort and money. Yes, money can be made on homes needing major renovations, even if they
are in less popular neighborhoods, but these are jobs for professionals, not homeowners (and definitely not for first-time homeowners!)

Avoid Surprises

The most expensive situations are often those that are the least expected--those nasty little (and often big) surprises that jump out at you. You can avoid many of these surprises, though, with a couple of easy steps taken BEFORE final commitment to a property.

1) Have the property thoroughly inspected. Have the inspector detail all obvious (as well as potential) defects in the property. NOTE: The seller may say "we are selling the house as-is, so NO inspections." Avoid this property like the plague.

2) Run the numbers. You must know the market values for houses in the neighborhood in which you are interested that need no repairs. Running the numbers means working them backwards to see how much equity or profit may be available (or even IF there will be any) in the deal. You will need to begin by computing the realistic value of the home when all repairs are made. From that point, you will need to subtract any selling expenses you will incur (commissions and the like) as well as the full cost of repairs and, most importantly, the amount of desired profit or equity.

$600,000: Expected Sale Price, Repaired
-40,000: Selling Expenses
-25,500: Repair Expenses
-50,000: Desired Profit/Equity
$485,000: Maximum Property Purchase Price

Don't be deluded into thinking that you'll be able to sell for more than the market value or do the repairs for less than the estimates. If the numbers don't fit--with a good amount of "wiggle room" for more expense or handling costs or if the property does not sell quickly--don't waste your time or your money!

Summing Up

When considering a fixer-upper, whether for resale or to live in with increased equity, go into the process fully prepared so you will avoid many surprises. For your first project, only consider structurally sound homes in good neighborhoods requiring cosmetic repairs only. Have any property you are considering fully inspected and then get firm estimates for all needed repairs. Most importantly, "run the numbers" to be certain that the potential for gain is truly there. If you are satisfied on all counts, you may very well be able to be successful with your fixer-upper project “Remember not making a decision is still a decision!

Housing as an investment

Housing is a key driver of the economy and continues to be a solid investment for the majority of American households. Housing provides steady returns largely unaffected by volatile movements in the stock market, and will be driven by a strong fundamental demand into the future.

Housing wealth has a more immediate impact on consumer spending than stock wealth and has sustained the U.S. economy since the beginning of this decade.

Homeownership is the traditional starting point for American families to accumulate wealth, according studies by the National Association of Realtors®, America’s leading advocate for homeownership.

NAR reports that the national median existing-home price increased 12.7 percent in 2005 and is projected to rise at a more normal rate of 5.0 percent this year. Since record keeping began in 1968, the national median home price has risen every year, even during recessions and periods of sales decline. Typically, in a balanced market, home values rise at the general rate of inflation plus 1.5 percentage points.

Buying a home should be approached as a long-term investment, providing both equity accumulation and tax benefits over time. Despite some high profile media reports, it’s important to note that most of the country has never experienced even a temporary downturn in home prices since modern recordkeeping began.

Low mortgage interest rates, a growing number of households, strong demographic factors, economic growth, and an improved labor market have been driving Americans in record numbers to purchase a home. In addition, over the last few years, Americans have shown a readiness to pull their money out of stocks and put it into real estate, often as a second home – a wise and practical move that provides safer returns in a tangible asset. In fact, one out of three of homes purchased are a second home – about a third of those are vacation homes and the rest are for investment purposes, generally to provide rental income.

Demographic demand also favors housing over the long term. The children of the baby boom generation, often called echo boomers, are the second largest generation in U.S. history. They total about 75 million people born from 1982 to 1995, and are just entering the years in which people typically buy a first home. In addition, the boomers themselves remain in peak earnings years, there is a strong immigration impact, and minority homeownership rates have been trending up.

The sharp changes in the financial markets over the last few years underscore the stability of residential real estate as a safe choice for consumers. Although it’s possible for local housing markets to experience temporary price corrections, most of the peaks and valleys in home prices that deviate from a normal, gradual increase tend to smooth themselves out during the typical period of homeownership.

Dollar for dollar, the rate of return on an individual’s cash downpayment on a house is substantial. Homebuyers typically use their own money to cover only a small portion of the purchase price, yet the home appreciation they realize is based on the total value of the property.

First-time home buyers make a median downpayment of 2 percent, while repeat buyers put 21 percent down – thanks to the equity they’ve build in their previous home.

According to Harvard University’s Joint Center for Housing Studies, there is a dramatic increase in the rate of return on housing the longer it is held. For instance, the typical homeowner who experiences an annual home appreciation rate of 5 percent and who made a cash downpayment of 10 percent will generally receive a 94 percent return on that cash after owning the home only three years. After owning for five years, a homeowner can expect a rate of return on the downpayment to increase to 225 percent; after 10 years, the rate of return jumps to 623 percent.

The stock market has experienced wide swings in value over the past 20 years. During that time, overall home values have continued to rise steadily and contribute significantly to household wealth and spending patterns.

Housing is not a quick-in, quick-out investment. When purchased for the long term, housing is one of the safest investments a consumer can make. In addition to the savings accumulated through a buildup of equity and tax advantages, a home provides shelter. No paper investment provides this benefit.

Homeowners accumulate significantly more wealth than renters. According to the Federal Reserve Survey of Consumer Finances, the median net wealth of a renter household is $4,800, while the median net wealth of a homeowner household is $171,700. Clearly, owning a home is the best way for most families to build a nest egg.

Homeowners use their home equity to get cash for emergencies as well as for the purchase of big-ticket items, and have more confidence in housing wealth gains than stock gains that could prove to be unsustainable. In addition, the capital gain people realize from the sale of their home is a significant source of downpayment funds for most repeat buyers; those funds are also used for other purposes that stimulate the economy through consumer spending. The above information and statistics are from the N.A.R. National Association of REALTORS

For more than 30 years, savvy real estate investors have used Individual Retirement Accounts (IRA) to purchase virtually any kind of fee-simple investment real estate, including:
• Raw or developed land
• Single & multi-family homes
• Condos, co-ops & townhomes
• Apartment buildings
• Commercial propertyTo do so, investors must open a Self-directed IRA with an IRS-approved Administrator, Custodian or Trustee and then have their retirement plan funds transferred or rolled over to their new account. Self-directed investing is regulated by state and federal banking regulations and IRS tax law. The term ‘Self-directed’ investing simply means that the investor chooses the specific asset to invest in, unlike purchasing a mutual fund, where assets are chosen by fund managers and other entities. Self-directed IRAs are no different than conventional IRAs, except that they allow investment in non-traditional assets, such as real estate and other investments.With a Self-directed IRA funded account, individuals can invest in real estate in many ways. If the Self-directed IRA has sufficient funds, the IRA can purchase the property outright; the asset is held in the IRA.

As owner of the land, the IRA must have sufficient funds to pay property tax, etc. Investors can also ‘partner’ with themselves or other qualified persons to effectively extend their purchasing power. Imagine having personal funds and IRA funds to effectively purchase the property such that each share would own “an undivided interest” in the property, which means they share all expenses and profits based on that pro-rata share. Similarly, investors have used legal entities, such as a Limited Liability Company (LLC) and Limited Liability Partnership (LLP) to invest in real estate. Finally, investors can direct their IRA to actually take out a mortgage to purchase rental property. These are called ‘non-recourse’ loans which are procured from specialized lenders and the loan’s repayment must come from contributions to or income from the property in the plan.Self-directed IRAs offer substantial tax advantages that have made many millionaire investors.

The greatest advantage is that IRA investors pay no capital gains tax when the property is sold by the IRA. In addition, because the profit from the sale is deposited back into the IRA with no tax on gain or growth, the investor enjoys the power of compound interest to invest in the next real estate deal. Although IRS 1031 exchanges can be used to fund partial IRA investments in real estate, Self-directed IRAs do not have the same limitations and holding periods, thus are much more flexible. Finally, if you’re like many investors who are tired of poor-performing investments in stocks, bonds and mutual funds, Self-directed IRAs offer true portfolio diversification; i.e., in real estate, to help build wealth via tax-deferred or tax-free income-generating assets! Your first step in purchasing real estate is to have a trusted Realtor who is knowledgeable in finding your ideal property.

Purchasing real estate with your IRA is very similar to conventional means, but IRS regulations must be observed. As with any investing, it’s always appropriate to have competent advice from tax and legal advisors. Beyond that, the best remedy to avoid problems with the IRS is to become an educated investor by reading or attending a workshop or seminar on buying real estate in an IRA offered by your local Self-directed IRA Administrator. For more information on Self-directed IRA investing, contact Julian Acosta, Director, Business Development for Entrust Administration Services in South Florida. Call 954-331-8072 or toll-free: 866-561-4472 or email at: jacosta@entrustfl.com




Gary Smith Key West Commercial Real Estate Broker

Gary Smith Broker
Keys Commercial Real Estate LLC.
1500 17th Terrace, Key West, FL. 33040
Direct - (305) 304-7009
E-Mail me

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